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Rekenthaler Report

Why PIMCO’s RealPath Funds Expired

They landed on the wrong side of history.

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Closing Shop
As of February 2020, PIMCO's RealPath target-date funds will be no more. The company is shuttering the series, for the usual reason of poor sales. The funds were launched a decade ago but possess only a collective $140 million. Worse yet, they have suffered more than $30 million in outflows so far this year. You don't need to have majored in math to understand those consequences.

Some liquidations are random; the fund performs badly, for its own reasons, and is therefore dispatched. This closure is not random. The failure of the RealPath series illustrates three realities of today's mutual fund business.

Active Management Is Unpopular
The first condition requires little explanation: The RealPath funds are actively managed. In 2015, in response to customer pressures, PIMCO introduced a second, passively run* target-date series, called RealPath Blend. It quickly outgrew its older sibling. Selling actively run funds has become challenging at best, and the 401(k) business, with its emphasis on rock-bottom expense ratios and avoiding lawsuits, has become particularly inhospitable. Once the indexed option was available, the original series looked to be doomed.

(*Technically, only RealPath Blend's equities are passively managed. As a fixed-income specialist, PIMCO has been reluctant to index its bonds. That hasn't proved a problem for sales because, as those who tout risk parity strategies correctly state, bonds are rather beside the issue. Stocks drive the performance of multi-asset funds. Also, the funds' bond portion has fared well, outdoing the Bloomberg Barclays U.S. Aggregate Bond Index since the series debuted.)

That said, the RealPath funds haven't helped their cause. Every RealPath fund carries higher expenses than does the analogous RealPath Blend fund, and every RealPath fund also has posted lower total returns. While there is good reason for the performance gap --to be discussed shortly--the fact remains that the results for the "new and improved" series have indeed been new and improved. It's easy to understand why plan sponsors switched.

On the Outside Looking In
The 401(k) field favors front-runners. Because plan sponsors are generally not investment specialists, and face litigious foes, they seek safety in numbers. They survey the field to see what other 401(k) sponsors are doing, then strongly consider joining that pack. As the saying goes, nobody ever got fired for buying IBM.

That means a relatively easy sales process for industry leaders Vanguard, Fidelity, and T. Rowe Price, and an uphill slog for everybody else. Should performance disappoint, plan sponsors who select providers outside the Big Three have some explaining to do-- particularly if their choice was a particularly small player, such as PIMCO, which ranks 30th among fund companies in 401(k) assets.

So whereas mutual fund companies traditionally lived or died based on their funds' returns, because performance was what mattered, not distribution muscle, things work somewhat differently with 401(k) plans. It takes truly extraordinary results for smaller providers to break through the glass ceiling. Being reasonably good is not enough. It may suffice to retain assets, but it will not attract new customers.

Against that backdrop, PIMCO was highly unlikely to continue offering two target-date series. It was tough enough to compete while being a niche provider, more prohibitive yet to do so while dividing the marketing effort. Ultimately, PIMCO's 401(k) town wasn't big enough for its active and (mostly) passive series to coexist. One had to go, and it was the one that didn't have history on its side.

The Right Idea at the Wrong Time
As suggested by the series' name, PIMCO differentiated its offering by emphasizing real returns. The funds held more securities that were perceived to protect against inflation than did its competitors. It had additional Treasury Inflation-Protected Securities, commodities, and real estate. That approach should have served the fund well during the 2008 financial crash. Holding more alternative investments meant being lighter in equities, which could only have been a good thing in late 2008.

Unless, that is, the alternatives happened to be commodities and real estate. The first sunk like a stone in the expectation of a global recession, and the second suffered because, after all, the financial crisis was sparked by a housing crisis. Had the RealPath series used alternatives-investment tactics other than commodities and real estate, for example, market-neutral or managed-future investments, then its funds would have comfortably beaten the S&P 500 during the fourth quarter of 2008. But it did not, and its longer-date funds fell along with the index.

That was bad luck: being positioned to fight the next war, having that next war occur, but not accruing an advantage. While the strategy matched the times, its implementation did not. The misfortune did not abate. Although the funds' alternatives rebounded after 2008, so too did equities, by an even larger margin. The series received no joy for its relatively conservative stance.

There was no joy, either, from its policy of protecting against stock-market "tail risk" by acquiring put options. Adopting that tactic was a form of insurance. In exchange for the modest, ongoing expense of purchasing options, the fund would receive protection should the stocks repeat their 2008 hijinks. All fine and good--except that the tail event never arrived.

Not surprisingly, the newer RealPath Blend series moderates its predecessor's approach. The 2045 fund, for example, has 6% in real estate, 2% in commodities, and 1% in TIPS. The remaining 91% is invested in conventional stocks and bonds. To be sure, that fund is modestly more "real" than the Big Three's offerings, which almost entirely dispense with alternatives, but it is nonetheless mainstream.

Wrapping Up
The mutual fund industry once favored organizations that assembled crack investment departments and that managed funds that did not resemble their rivals. Gradually, over time, the idiosyncrasies have been smoothed out, as investors have come to value the reliable virtues of low cost and predictability over the less-dependable promise of outperformance. Although young by the calendar, PIMCO's RealPath series was old by the trends. It became dated before its time.

 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.